It’s hard to come up with new ways to describe the Obama administration’s improvisational approach to the Affordable Care Act’s troubled health insurance exchanges. But last night, the White House made its most consequential announcement yet. The administration will grant a “hardship exemption” from the law’s individual mandate, requiring the purchase of health insurance, to anyone who has had their prior coverage canceled and who “believes” that Obamacare’s offerings “are unaffordable.” These exemptions will substantially alter the architecture of the law’s insurance marketplaces. Insurers are at their wits' end, trying to make sense of what to do next.

Previous fixes were failing

Here’s how we got to where we are. As many as six million Americans who purchase health coverage on their own have seen their plans canceled, because they don’t comply with Obamacare’s newly-imposed regulations. On the other hand, the bungled rollout of the law’s healthcare.gov website has meant that only tens of thousands of Americans have been able to enroll in new coverage under the law. This means that by January 1, 2014, less people will have health coverage under Obamacare than before.

The White House has been working hard to fix the problems with the exchanges, with modest success. Henry Chao, the deputy Chief Information Officer at the Centers for Medicare and Medicaid Services, testified to Congress in November that 30 to 40 percent of Obamacare’s exchange software had yet to be constructed. Most critically, the systems needed to pay insurers—and thereby enroll people in coverage—had not yet been built.

The administration announced in November that it would decline to enforce the provisions of Obamacare responsible for the cancellations, thereby giving states the option to allow insurers to attempt to keep the old plans operational. But the reality turned out to be more challenging; it’s not easy for insurers to turn on a dime and re-create insurance products that they had previously canceled in compliance with federal law.

In other words, for all of the seeming flurry of activity, as of yesterday the fundamental problem—people losing their old health plans, and failing to gain new ones—remained.

White House admits that Obamacare plans may be ‘unaffordable’

Last night, in a stunning reversal, the Centers for Medicare and Medicaid Services announced that Americans who have had their plans canceled will be exempt from enrolling in the exchanges, “because some consumers were finding other coverage options to be more expensive than their cancelled plans or policies.”

For years, these pages have raised the concern that the “Affordable Care Act” will drive up the cost of health insurance. “What is remarkable about the Patient Protection and Affordable Care Act,” I wrote in 2010, is “its devastating consequences for the cost of health insurance.” A 49-state analysis I conducted along with two colleagues at the Manhattan Institute found that the average state will see underlying premiums increase by an average of 41 percent in the individual market, the market where people shop for coverage on their own, instead of getting it through an employer or the government. (Our state-by-state interactive map can be found here.)

But this most recent announcement from the Obama administration is the first time it has publicly admitted that Obamacare is making health insurance less affordable, not more so, for millions of Americans.

The new ‘hardship exemption’ applies to those with canceled coverage

Section 1411(c)(5)(A) of the Affordable Care Act grants the Secretary of the U.S. Department of Health and Human Services the power to grant a “hardship exemption” from the individual mandate that requires most Americans to purchase health insurance or pay a fine. The administration has, in effect, declared that Obamacare’s regulations are themselves a “hardship” worthy of mass exemption.

“If you have been notified that your individual market policy will not be renewed, you will be eligible for a hardship exemption,” announced the Centers for Medicare and Medicaid Services. All you have to do is “complete a hardship exemption form, and indicate that your current health insurance policy is being cancelled and you consider other available policies unaffordable.”

Obamacare’s ‘catastrophic plans’ are also unaffordable

The administration has also expanded the availability of the law’s so-called “catastrophic” plans. But the catastrophic plans under Obamacare aren’t like the ones you might be familiar with. ACA-compliant “catastrophic plans” have to cover all of the services defined as “preventive” by the government, along with all of the Obamacare-defined “essential health benefits,” like drug-addiction therapy.

The major difference between the regular Obamacare “bronze” plan and the Obamacare “catastrophic” plan is that the catastrophic plan covers three primary care visits prior to hitting the deductible. Which isn’t that much of a difference at all.

The catastrophic plans are supposed to be available only to those under 30, and those older than 30 who can’t find coverage for less than 8 percent of their income. And the catastrophic plans are not eligible for Obamacare’s premium support subsidies.

The upshot of all this is that the catastrophic plans aren’t that much cheaper than the regular Obamacare plans. In California, for example, the median cost of a pre-Obamacare plan on eHealthInsurance.com, for a 25-year-old male non-smoker, was $92. The Obamacare bronze plans cost an average of $205 a month. The Obamacare catastrophic plans? $184. In some parts of the country, the catastrophic plans are actually more expensive than the bronze plans.

For this reason, I don’t expect many Americans to sign up for the catastrophic plans. If you think that the Obamacare bronze plans are unaffordable, you’re likely to feel the same way about the catastrophic plans. Instead, you’re going to take advantage of the “hardship exemption” and go without insurance altogether.

Insurers have no idea what to do now

This decision by the administration—characterized by HHS Secretary Kathleen Sebelius as an attempt to provide “the smoothest possible transition” into the Obamacare era—has instead thrown the individual insurance market into chaos.

Here’s why. Insurers like Aetna and Humana, when they priced their plans for the Obamacare exchanges, did so by averaging the expected health spending by the people who would sign up for those plans. This new “hardship exemption” will encourage healthier individuals, whose expected spending would be low, to drop out of the pool. As a result, average spending per enrollee on the exchanges is likely to be substantially higher than the insurers had planned for, forcing them to lose money on their policies.

“This latest rule change could cause significant instability in the marketplace and lead to further confusion and disruption for consumers,” said Karen Ignagni, president of AHIP, the insurer trade group, last night. That’s especially true if enterprising Americans generate fake cancellation letters, in order to avoid Obamacare’s individual mandate.

And the catastrophic plans, as I noted above, were priced by the insurers on the assumption that the vast majority of enrollees would be under the age of 30. If healthy but older people sign up for these plans, insurers will lose money on them, too. “Panic mode” is how insurance executives are describing the administration’s moves—but the insurers themselves are going to have to wonder about the financial viability of their exchange-based plans.

Exempting the insured, but not the uninsured, from the individual mandate

The mass exemption appears to have been precipitated by several Democratic senators in Republican-leaning states who were concerned about the political blowback from the cancellation conflagration. Secretary Sebelius sent a letter yesterday to Sen. Mark Warner (D., Va.) thanking him for his “constructive leadership on this issue.”

Republicans, however, are certain to repeat their calls to exempt everyone from the individual mandate. Why, after all, should uninsured people be forced to buy unaffordable coverage, but not the previously insured?

And it’s worth remembering that these exemptions are only a temporary reprieve, for the 2014 plan year. In 2015, without further decrees from the White House, all of the delayed Obamacare provisions will snap back to attention. In the meantime, we’re left to wonder: what will they think of next?

INVESTORS’ NOTE: The biggest publicly-traded players in Obamacare’s health insurance exchanges are Aetna (NYSE:AET), Humana (NYSE:HUM), Cigna (NYSE:CI), Molina (NYSE:MOH), WellPoint (NYSE:WLP), and Centene (NYSE:CNC), in order of the number of uninsured exchange-eligible Americans for whom their plans are available.